2005 June 16 Thursday
Andy Xie Of Morgan Stanley Foresees Oil Price Collapse

Andy Xie sees oil prices currently being held up by speculation while the fundamentals have shifted toward oversupply.

China’s oil imports declined by 1.2% YoY in the first five months of 2005. US oil inventory increased by 6.4% in the first quarter of 2005. However, oil prices averaged 46% higher in these five months of the year and 50% higher in the first quarter, on a YoY basis. How to bridge the gap between rising prices and weakening demand? The answer, I believe, is that there are too many oil traders engaging in oil price speculation. They will likely keep prices up until an oil market collapse. That day is not too far away, I believe.

The global economic cycle looks to have peaked out, but the deceleration has been modest so far. This is why financial speculation can still bolster the oil price. I expect economic deceleration to deepen in the fourth quarter of this year, such that the oil bubble may then burst. The trigger could be a sharp drop in China’s crude imports.

Xie sees China's oil import surge due in part to a shortage of coal electric generating capacity. As more coal-fired generators come on line oil will become uncompetitive for electric power generation in China (as it already is in America).

As substitutes come on line Xie expects a bear market for oil that will last for many years.

The high oil prices have triggered an investment boom in oil exploration and the production of substitutes. Oil sands, LNG, coal liquification and gasification are competitive against oil at US$20-25/bbl. As fixed investment piles into such alternatives, the energy supply curve has been permanently shifted outward, in my view. The current investment boom and the production capacity to follow may keep a lid on oil prices for many years to come.

Xie also sees businesses around the world responding to the current high oil prices by investing in equipment that raises energy efficiency.

Advances in battery technology would increase the extent to which different energy sources could substitute for each other. With sufficiently cheap and light batteries liquid hydrocarbons would cease to be the only practical energy choice for ground transportation. Nuclear, coal, wind, solar, and natural gas could all power cars by being converted into electricity. Also, the unreliability of wind and solar would pose much less of an obstacle to their use. Therefore in my view the biggest flaw in the US government's energy policy is insufficient money for battery research.

Share |      By Randall Parker at 2005 June 16 12:31 PM  Economics Energy

PacRim Jim said at June 16, 2005 1:33 PM:

Short petroleum.

Invisible Scientist said at June 16, 2005 2:48 PM:

Although it is rue that the coal liquification and tar sands offer tangible solutions to the oil shortage problem, the problem is that the infrastructure for these avenues, is still years away, and even if China slows down, the long term demand for oil, including the Chinese demand for oil, which will continually increase in the long run. In fact, if the price of oil starts to drift back to the $35 per barrel level, the incentive to invest in alternative fuel sources like coal liquification or tar sands, will disappear, since it takes an initial investment loss to get the new infrastructure going...

Stephen said at June 16, 2005 5:43 PM:

The Dept of Energy weekly petroleum bulletin says:

Some analysts look at U.S. crude oil inventories, which have been above the average range for several weeks now, and see a market with plenty of crude oil available. These analysts see speculation and a shortage of global refinery capacity as the main culprits behind the high prices seen this year. This camp would see prices declining significantly later this year after the peak refining season ends, especially if the “speculation bubble” bursts. Concerns about supplies being extremely tight this upcoming winter are unfounded to these analysts, as they expect non-OPEC production to increase significantly between now and the end of the year, adding enough supply to meet the expected increase in demand without much additional oil needed from OPEC countries.
However, there are other analysts who do not envision a substantial increase in non-OPEC supplies or a dramatic slowdown in global oil demand growth in 2005 or even 2006. Without significant increases in non-OPEC production or a slowdown in demand growth, these analysts forecast that when product demand peaks during the winter, the currently tight oil market will get even tighter and crude oil prices may once again test historical highs (in nominal terms). Concerns about weather, both on the supply side from the possible impact of hurricanes later this summer, to cold weather this winter increasing demand, also are key factors to these analysts. In fact, the first storm of the season, Tropical Storm Arlene, was fairly mild and did not impact oil and natural gas production significantly in the Gulf of Mexico, yet was one of the factors that caused prices to rise over the last few days. With markets as tight globally as they currently are, even a relatively mild tropical storm can have an impact on prices. Analysts with this view of the market see relatively low inventories in Asia counterbalancing ample crude oil inventories in the United States, and wonder what another storm like last year’s Hurricane Ivan might do to prices this year, should one of that magnitude and location occur again. If these analysts are correct about the near-term path of crude oil prices, this summer may turn into a cruel one for U.S. consumers after all.

My feeling is that high prices have more to do with speculation and refinery capacity (the refineries are essentially operating at 95%+ of theoretical capacity).

I'm not sure if the high prices are actually encouraging investment in alternatives. I think that investors will wait and see if the prices are permanent or merely a bubble. That said, I read somewhere that China is going nuclear in a big way - building something like 80 reactors over the next 20 years. I also read that China is thinking about spending a tiny fraction of its massive foreign currency reserves to buy futures contracts for 1 Billion barrels of oil. But the US doesn't want them to do this because China would most likely use some of its excessive US dollar reserves to pay for the crude.

Invisible Scientist said at June 16, 2005 5:54 PM:

"I'm not sure if the high prices are actually encouraging investment in alternatives. I think that investors will wait and see if the prices are permanent or merely a bubble.

That said, I read somewhere that China is going nuclear in a big way - building something like 80 reactors over the next 20 years."

Making some intermittend downward price fluctuations, is in the interest of the oil producers, since this would cause the investors to hesitate and delay the building of liquified coal and tar sands facilities...

But even if China builds 80 reactors in 20 years, this will be ONLY a small fraction of their electricity needs,
much less than 10 % of their needs in 20 years.

Randall Parker said at June 16, 2005 5:58 PM:


I saw the Saudi oil minister blaming oil refinery shortages for high oil prices and I just don't get it. If the refineries are maxed out then they can't buy more oil since they would have no way to process it. A refinery bottleneck would place a ceiling on the demand for oil (at least in the United States).

Now, if there is some form of oil that can not be processed due to lack of refineries for that type of oil then I could see why that would cause the price of other types of oil to be higher. But the Saudis are supposedly (at least as far as I can tell) the only ones with special heavy oil production capacity that is sitting unused.

I have a hard time believing that the Saudi heavy oil would make the difference if refineries could process it. BTW, the US has refineries that can process heavy oil and the US buys Venezuelan oil for those refineries. Is Saudi oil also compatible with those refineries? Are those refineries already at max capacity?

The question in my mind is just how fast will other energy sourcse come on line in response to the current high oil prices? Canada is ramping up oil tar processing. But it takes years to build new capacity. Also, how fast will Chinese coal burning electric plants come on line? How much Chinese oil importation goes to electric generation?

Also, how rapidly are businesses investing in capital equipment that uses energy more efficiently?

If Asian oil stocks are low then why at the same time have Chinese oil imports fallen? Is this a sign that the the US is willing to pay more than China for oil?

Engineer-Poet said at June 16, 2005 6:42 PM:

If Venezuela's oil is only worth shipping as far as the USA because of its low value, there may be many other deposits of heavy and/or high-sulfur stuff worldwide that are known but not produced.

Randall Parker said at June 16, 2005 8:23 PM:


No, I get the impression that the US built the special refineries because the US has such a voracious appetite for oil and the US is further from the Middle East than Europe is and the American oil companies wanted to avoid being vulnerable to another embargo or other Middle Eastern political problems. Venezuela is not that much further from Europe than from the US.

The Venezuelan oil sells for less due to its poorer quality. I don't know how much distance changes the price of oil. How much is shipping cost versus purchase cost? My guess is that shipping cost is well less than a dollar a barrel even from the Middle East to the United States. But that is a guess.

Now that Hugo Chavez is in power and he hates the US he's signing deals with other countries to eventually import Venezuelan oil and oil companies in those countries are have refineries modified to be able process Venezuelan oil.

Stephen said at June 16, 2005 8:45 PM:

On the domestic market (refinery -> retailer), if the refinery can supply every drop it makes, then its a sellers market and prices rise. Traditionally, refineries have been price takers when they tried to clear their excess production - but there's no longer any more excess. Also, once there were lots of independent refineries. Both of those factors tended to inject price competition into the domestic market.

As for the international market (ie the price for crude), I think that its driven purely by speculation rather than supply - ie commodity traders have been betting that middle east stability will be reduced by the Iraqi adventure. Also, I read last year that the price charged by supertankers has increased dramatically.

There's apparently 1 trillion barrels of proven reserves (ie reserves that are real and are economically exploitable at normal prices). On top of that there's the reserves that are economically exploitable at today's inflated prices, but which no one will exploit because developers suspect current pricing is merely a bubble. So, in a solely economic sense, its a waste of money to invest in alternatives to oil for vehicles.

I'm actually reasonably confident that crude prices will drop as eastern Europe and more non-OPEC come on line, but in the medium term I think that drop will be short lived because China and India will become huge buyers.

I don't think that Saudi heavy requires any special refinery processes - there's nothing really special about it from a chimist's perspective. I'm at the edge of my knowledge, but this is how I think it works: Basic oil refining is reasonably simple - you heat the crude and at various temperatures you syphon off the components that 'evaporate off' (ie LPG, kero etc). Crude from different places gives a different ratio of components, but fundamentally oil-is-oil and any refinery can handle even the heaviest and sourest crude. Hydro-cracking is an additional process that lets you mess with the component ratios (this is a generally useful facility to have, but is especially useful for heavy crude) and in a related process lets you extract sulphur. Comparatively speaking, cracking facilities aren't very expensive or complicated. Most refineries in western Europe crack - but not because North Sea oil is heavy (its not), but because of an EC policy promoting diesel and low sulphur.

As a general rule 70% of oil is used for transport (in the 1950s it was only 50%). While vehicle efficiency massively improved in the late 70s/early 80s, that gain has now stopped (indeed, it might be regressing - think SUVs etc). Apparently there is still room for 30% improvement in vehicle fuel efficiency, but that's not happening because consumers are still willing to pay for heavy fuel guzzlers.

Stephen said at June 16, 2005 8:48 PM:

I read that the Saudi's bank around $22.50 after costs for their crude sales.

Invisible Scientist said at June 16, 2005 9:22 PM:

I have read some speculation that the fuel efficiency of hybrid cars can ultimately be raised to wiell over 100 miles per gallon in a few years... If this happens,then even if the cost of making fuel from coal is $50 per barrel, the US can achieve 100 % independence from oil. There is enough coal for many centuries in the US.

gcochran said at June 17, 2005 12:16 AM:

Production and shippping cost of Saudi oil is probably under $3 dollars: the rest is profit. So closer to $50 profit per barrel than $22.50

Ned said at June 17, 2005 5:30 AM:

Interesting ling to, "Winning the Oil Endgame," about reducing US dependence on foreign oil:


Marvin said at June 18, 2005 6:30 AM:

All of this is badly complicated by the phenomenon of global warming. Most Europeans believe global warming to be the largest threat to humanity, far more threatening than the global reach Islamic terrorism, nuclear proliferation, the danger from an unexpected asteroid strike, or China's beefed up belligerency.

Global warming threatens to force a cold winter next year, increasing fuel oil usage dramatically. We learned that global warming causes frigid temperatures from a popular film last summer. When the oceans freeze and the supertankers can no longer cross the oceans, you will know that global warming has finally reached its peak.

Randall Parker said at June 18, 2005 9:14 AM:


We are at far far greater risk from avian influenza than we are from global warming. Yet I don't see people meeting to draft international agreements on the H5N1 strains of bird flu spreading thru East Asia.

My view of global warming is that the political problems caused by the Saudis and by high oil prices are already enough to warrant the development of alternatives to oil. If we pursue advances in the most obvious areas (nuclear, photovoltaics, batteries) we will reduce CO2 emissions as a side effect.

crush41 said at June 18, 2005 7:34 PM:

Global warming threatens to force a cold winter next year, increasing fuel oil usage dramatically. We learned that global warming causes frigid temperatures from a popular film last summer. When the oceans freeze and the supertankers can no longer cross the oceans, you will know that global warming has finally reached its peak.

That's a joke, correct? Sarcasm is tough to detect in a forum like this, but global warming suggests, well, warming temperatures, not the next ice age. Am I off somewhere, or were you just suggesting European irrationality will make things even more complicated?

Marvin said at June 19, 2005 9:53 AM:

I have a good supply of Tamiflu, so I'm not afraid of avian flu. Laurie Garrett can scare a lot people into giving her a lavish lifestyle and a sinecure at the CFR, but to me she's just a hack.

Global warming is an undisputed fact, in the northern hemisphere anyway. I've noticed distinct warming in the northern hemisphere over the past few months. I suspect that this warming, hemispheric warming to be more exact, will be followed by some extremely cold temperatures in the northern hemisphere in the following months. Does the warming cause the cooling? We can't take the chance. We have to shut down the industries in the largest polluting nations just to be safe. Why does anyone burn petroleum distillates when they are such good feedstocks for so many important manufactured goods?
Acid rain pollutants contain many chemical compounds that run into the ocean. Some of these compounds may be related to ice-9, a dangerous pollutant when it comes in contact with water. Supertankers that come in contact with ice-9 polluted water will suffer the fate of the Exxon Valdez and the Titanic.

Randall Parker said at June 19, 2005 11:44 AM:


Laurie Garrett is hardly the only person who says that avian flu might mutate into a from that is easily transmissible between humans. If tens or hundreds of millions die are you still going to be claiming that people who are warning of the danger are alarmists?

Influenza strains from other species do cross over into humans and cause pandemics. The H5N1 strain in Asian birds has been extremely lethal in the small number of known human cases. It could recombine with an existing human strain to produce a strain that is more transmissible in humans and very lethal. This is not implausible. Again, it has happened within the lifetimes of some people who are alive today.

So you personally detected warmer temperatures and decided that global warming is an undisputed fact in the northern hemisphere? But is it caused by humans? The weather normally varies considerably from day to day, season to season, year to year, and over centuries and longer periods of time. If humans were not releasing massive amounts of CO2 we'd still be having seemingly unexpected (at least unexpected by those who expect everything to stay the same) warm or cold summers and winters.

In case anyone doesn't know: Ice-9 comes from Kurt Vonnegut's novel Cat's Cradle and Ice 9 turned the whole world to ice.

Nick said at June 20, 2005 2:08 PM:

hmmh. I think Marvin is just trying for humor.

I still don't get the Saudi's claiming that refining shortage is raising prices. Like Randall, I started to think they were saying that high-sulphur oil was available at low prices, and that more refinery capacity for that kind of oil would reduce prices for low-sulphur oil, but now Stephen says that any refinery can process high-sulphur oil. Is Stephen wrong?

Randall, I think Chinese demand for oil is for diesel for stand-alone electrical generation to supplement the chinese grid, which is largely coal. As I understand it, the grid gets overloaded in summer, which is why that's when imports peak. Winter demand may not be predictive.

FriendlyFire said at June 20, 2005 5:24 PM:

Humour ?

Well the spanish Influenza killed more people then worldwar 1 which preceeded it did.
Globe warming has the capasity for less but perament damage. A simple change in ocean tempature from current by a mear 3Degrees celcius will result in perfect water tempature in which hurricans form.

Bob Badour said at June 20, 2005 6:05 PM:

Humour? Yeah, humour. I think Marvin's dire predictions about a cooling trend from summer to winter were intended as humour a la Robin William's weather reports in "Good Morning Viet Nam" predicting darkening at dusk followed by brightening toward dawn.

Randall Parker said at June 20, 2005 6:34 PM:


The case for global warming's causing more hurricanes is as yet unproven. I would suggest you read up on the scientific flap over Chris Landsea's resignation from IPCC over this very issue. That flap has just hit another turning point with a new paper in Science by Kevin Trenberth. I happen to have a bunch of links to this because of a list I'm on. Read here:

Most hurricane experts insist that there's no clear link between an increase in tropical storms since 1995 and any long-term change in global temperatures, which scientists think have been rising gradually for the past century.

"There is no reasonable scientific way any such interpretation of this recent upward shift in Atlantic hurricane activity can be made," said Colorado State University tropical-storm researcher William Gray, who predicted the recent surge in storms and expects them to continue.

Gray's culprit isn't greenhouse gases and global warming, but a long-term change in the salinity and deep-ocean currents of the North Atlantic that results in warmer surface temperatures and makes hurricanes more likely to form.

Trenberth contends in his paper that statistical models used in most hurricane forecasting simply don't capture the impacts of global warming.

Also see:

Globally, the number of hurricanes and typhoons tends to hold relatively steady from year to year. When activity increases in the Atlantic, it often decreases in the Pacific, and vice versa, based in part on El Ñino and La Ñina.

Trenberth points out that, because hurricane numbers vary so greatly on a regional level from year to year and decade to decade, it is difficult to use statistical techniques to extract longer-term trends in the number of hurricanes that form and where they move.

"There is no sound theoretical basis for drawing any conclusions about how anthropogenic climate change affects hurricane numbers or tracks, and thus how many hit land," Trenberth says.

See Roger Pielke's coverage on the Prometheus blog:

Trenberth confirms in his Science essay what Landsea has claimed, that -- based on what is known today -- "there is no sound theoretical basis for drawing any conclusions about how anthropogenic change affects hurricane numbers or tracks, and thus how many hit land." None. There is no basis for claiming as Trenberth did that the hurricanes of 2004, much less their damages, could be attributed to human emissions of greenhouse gases/global warming. Earlier this year, Trenberth said that his participation in the Harvard press conference was "to correct misleading impressions that global warming had played no role at all in last year's hurricane season." It is good to see this claim corrected.

On that blog you can read more about it than you'll ever want to know. One point to keep note of if you go reading on this: There is a difference between frequency of hurricanes and intensity. Conceivably a warming could increase one but not increase the other.

Also read Chris Landsea's IPCC resignation letter.

My take on global warming is that we have more immediate things to worry about. But if we are to assume that global warming will happen and that it will be a Bad Thing then my advice is we should deal with it by accelerating research on photovoltaics and nuclear to lower their costs. Then the market will see to it that solar and nuclear displace fossil fuels. We will get cheaper energy and solve environmental problems at the same time.

FriendlyFire said at June 21, 2005 2:26 AM:

very interesting read. I stand corrected.
It dose go some way into explaining to increased magnitude of hurricans and violent storms.
At least all that lighting is producing ozone.

ian dunn said at June 13, 2006 1:54 AM:

I do enjoy the Adam Smith theories that the invisble hand will find a suitable solution to oil... and I must point out right now that I am very bearish on the long term future of the global economy still dependent upon Oil. I have read the optimistic spins that have been coming out (even more since this report first was released in 2005), especially on the production of substitutes and I do hope that there is long term substance to their remedies. But right now all the substitutes currently proposed have an energy ratio (the amount of energy that you get from the fuel, to the amount of energy required to obtain the fuel) much less than oil (meaning that more of the substitute needs to be produced to produce the same energy required to replace oil, for the same energy invested), plus the energy required to make these substitutes is currently still coming from fossil fuels. Plus the Nuclear, which has one of the lower energy ratios I might point out, cannot be used to make raw materials like plastic and fertiliser which are currently obtainable from crude oil.

Bearish times ahead.. and one of the reasons why the oil price didn't collapse when this article was released, and as time goes by, it seems that faith in the invisble hand (which cannot deny the laws of Physics)to form a solution alas might be mis-placed.

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